Speculating with Sector Funds

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Speculating with Sector Funds

It can be so tempting to dive into a part of the market that you think will soar based on some trend, an analyst’s recommendation, or your gut. This kind of speculation is very risky, but if you must do it, do it sensibly. Many experts suggest that you reserve a very small slice of your portfolio—say, 5% or less—for such activities and make sure the remainder of your portfolio is well-diversified and designed to meet your long-term investment goals with a level of risk that is acceptable to you. Finally, understand that when you speculate, you may be wrong—in other words, be prepared to lose that 5% of your portfolio.

Watch the heat

You might also avoid buying a fund that’s already hot. Investors who fall prey to that temptation may overlook underappreciated funds. If a fund is hot enough to catch investors’ attention, many of its holdings may sport tremendously high price multiples. Investors chasing such hot funds can wind up losing money when the companies they hold fail to live up to the lofty expectations embedded in their prices.

A simple strategy if you can’t resist

If you can’t resist the temptation to bet on a sector, though, you can do one of two things: either play long-term trends (the aging of the Baby Boomers and increased demand for health care is one such trend) and dollar-cost average (invest a set dollar amount each month) into your sector fund, or consider making a bet on an out-of-favor sector, particularly one that most other fund investors are avoiding. Because the average investor doesn’t have such good timing, you may be able to outperform by buying what most investors are selling.